Sanofi and Boehringer Ingelheim swap units: a new model for pharma deals to come?

M&A activity in the pharma space has focused on seeking mega-mergers structured as a tax inversion, where the surviving company is domiciled in

the lower tax rate jurisdiction. This structure has come under vociferous criticism, especially in the U.S., where the claim has been made that U.S. companies are seeking to flee the US solely for achieve tax benefits. The poster child for this kind of transaction was the proposed $160 billion deal between Pfizer and Allergan, which called for Pfizer to relocate to Ireland and to reap tax benefits of $1 billion a year. The deal was scrapped in early April, after new tax regulations made the transaction less unattractive.

But if mega-deals with a sizeable tax consequence, such as the proposed Pfizer and Allergan merger, are now less likely to occur, this does not mean that pharma transaction activity will come to end. An illustrative example of what such future deals may look like can be found in the announcement at the end of June that the French pharma company, Sanofi, will hand-over its Merial animal medicines business (estimated to be worth $14.4 billion euros) to Boehringer Ingelheim, in exchange for the latter’s non-China over-the-counter medicines’ business (estimated to be worth 6.7 billion euros), plus the payment to Sanofi of $4.7 billion in cash. Stripped to its essentials, the deal harkens back to the most ancient form of transaction, namely barter. For those readers who seek a more contemporary analogy, view the deal as the exchange of one sports player for another, plus the payment of some cash by one of the teams. However one views this deal, it is far-removed from the world of mega-deal tax inversions.

A recent interview on Bloomberg radio suggested several advantages to this type of transaction:

First, there is less or no risk that the regulator will turn down the transaction. Not only is the mere risk of regulatory rejection deleterious to the business plans of the companies involved, but the failure to consummate the agreement may well obligate one company to pay the other a break-up fee.

Second, the challenges of integration, as each company seeks to absorb the unit acquired, should be significantly reduced in comparison with the full-fledged merger of companies, as in the current transaction, where only one dedicated unit from each company will be involved. Presumably, there will be less disruption to the activities of these units, each of which can continue to carry on as usual, Management teams will also largely be left intact, although not entirely, as Boehringer announced, only days after the deal had been announced, that it was cutting 50 positions at his headquarters in Ridgefield, Connecticut.

Third, tax consequences would appear to be taking a back seat to the issues of product strategy. Each company is presumably strengthening itself in an area what it hopes to reap competitive advantage. Here, as well, the risk of success or failure for each company in exiting one drug area while entering another is less cosmic than the ultimate risk of a full company merger gone bad. Indeed, the modularity of the transaction may portend a different focus for pharma companies. Big may be good for its own sake, but if the regulator puts its foot down on such moves, company management will need to find alternative forms of transactions to improve company performance.

One also wonders whether this kind of transaction will be better for the R&D and the IP position of the companies involved. Much has been written about the patent cliff facing pharma as block-buster drugs are coming off patent. The question is whether R&D can come up with replacements, even if this means more specialized drugs in place of these block-busters. From this perspective, the transactional focus on discrete units, rather than on entire companies, might assist pharma, especially Big Pharma, in coming up with a new generation of successful products.

Forget Mount Everest: Try Overcoming This Patent Cliff

One of the most crucial IP-related stories to be played out over the next few years is the manner in which Pharma deals with the impending patent cliff at the edge of its patent portfolio. Simply put, with a significant number of blockbuster drugs set to come off patent protection over the next few years (if they have not already done so), and the relative paucity of a new generation of patents to support a further generation of patent-protected blockbuster products, the question is how the industry will cope with this looming threat to its current business model.

Against this backdrop, collaboration is all the rage. The most recent example of such coping behaviour, as reported by Reuters, was announced last week, whereby Amgen and AstraZeneca agreed jointly to develop and sell five new biotech products that are in various stages of development at Amgen, here. Under the agreement, Amgen, the world's largest biotech company, will receive an upfront payment of $50 million. The companies will share then share both costs and revenue for drugs in several disease categories--autoimmune, inflammatory and respiratory ailments.

There is almost a textbook-like quality to the rationale offered for the deal as described in the Reuters article.

1. "The collaboration will provide Amgen with additional resources to help advance its product portfolio and give Astra access to new medicines at a time when its own pipeline is relatively barren and it is facing competition from cheap generic versions of its big-selling antipsychotic drug Seroquel". Stated otherwise, while Amgen is hardly a small actor in the biotech space, its strength still resides in its R&D capabilities, while AstraZeneca seems almost prototypical in its need to obtain new products and technology that it can then leverage at the marketing, distribution and sales levels.  

2. " 'We have a lot of things that we want to move forward and there are financial constraints everywhere with how much you can do," Joe Miletich, Amgen's senior vice president for research and development, said in a telephone interview. ... We still have many more things that we're still moving on our own, and this actually will help free some resources so we can continue to innovate in bringing some of the programs in our earlier pipeline along in a way that might not have been possible if we were funding these all on our own,' Miletich said." Stated otherwise, while Amgen may be the proverbial 800 pound gorilla in the biotech space, even 800 pounds is not enough to support the full complement of skills and resources needed both to develop and bring to market new drugs.

So is this as close to a "win-win" collaborative arrangement as one can hope for in the inherently high risk world of drug development, whereby each party to the agreement brings its particular competency to bear? Or is this yet another example of "me-tooism" in an industry desperate to find workable models in the face of the looming patent cliff and the relentless challenge posed by generic companies to the existing product mix?

Seer-like skills are beyond my pay scale, but others seem less daunted. Particularly telling are the words of Geoffrey Porges, a biotech analyst at Sanford Bernstein. Thus Porges makes the following acerbic observations:

1. " 'It's hard to see what AstraZeneca brings to the table other than cash and the ability for Amgen to maintain their share buybacks and dividends,' Porges said, conceding that Astra does provide some global commercial reach that Amgen lacks."  

2. " 'The fact that Amgen has to partner yet another one of their strategic initiatives isn't really going to fill investors with very much confidence,' said Porges". 

 But the problem of investor confidence is not limited to the Amgen side of the equation. The article reports that AstraZeneca has notably failed in developing experimental medicines for depression, ovarian cancer and diabetes. If the collaboration is meant to allay such investor anxiety, then the critical comments from an analyst such as Porges, affiliated with a prominent financial company, augurs poorly in that regard, at least for the short term. The more troubling question is whether, if Porges is right, there is any promising model that offers a reasonable of enabling Pharma to successfully deal with its patent cliff problem. The forthcoming Facebook IPO may be the hottest discussion topic in the high tech world, but something tells me that the resolution, or lack thereof, of Pharma's patent cliff problem will have greater long term consequences for both business and societal well-being. Media -- take note.

The Patent Cliff: A Coda

As a coda to today's post, attention is drawn to the attached article here that appeared on Bloomberg with a by-line date of April 15th ("Drugmakers Posed to Report Biggest Decline Since 2006"). The losses are attribute the fact that "the companies cope with record patent losses in 2011."

And so the challenge to Pharma becomes increasingly immediate and increasingly substantial.

What To Do in the Face of a Patent Cliff: A View from Medium Pharma

Once again, a potential substantial takeover in the pharma business has hit the headlines. And once again, the motivations for the proposed acquisition raise questions about how Big (and Medium) Pharma see the future of their industry. This time the parties are Canada's Valeant Pharmaceuticals International, Inc. and the target of their hostile offer, Cephalon, Inc. a U.S. rival. As reported at the end of March, Valeant made an all-cash offer for all of Valeant's shares, based on a valuation of $5.7 billion. This amounts to nearly a 25% premium over the closing price of Cephalon at the eve of the offering. Funding will be provided by Goldman Sachs. Valeant has also indicated that it intends to replace replace Cephalon's board if the acqusition takes place.

The motivation for the the transaction, as described in a March 30, 2011 report in wsj.com, is as follows (here):

"The offer suggests just how much the anticipated loss of revenue from patent expirations on key products is re-shaping the pharmaceutical industry. As drugs lose patent protection in coming years, drug makers stand to lose hundreds of millions of dollars of revenue and are searching for growth through acquisitions that plug those expected holes and allow companies to cut costs."

My interest is less in the dynamics of the hostile offer itself (I leave that to my M&A colleagues down the hall) and more on the commercial thinking that was reported to lie behind Valeant's offer. The following points are noted: 1. Cephalon faces a patent cliff in 2012, especially for its Provigil-branded narcolepsy product, with the expected concomitant loss in revenue that will follow such loss of patent protection. 2. The two companies share branded generic businesses in Europe and the acquisition will enable Cephalon to achieve cost-cutting in this area. This will help the company make up at least a part of these projected revenue losses.

Lying behind these two considerations are two quite different views of how Pharma should address the challenge of declining revenues in the face of a patent cliff. Cephalon's position seems to be that the company has acquired several promising compounds and it is confident that its development activities with these compounds will bear fruit in the coming years.

By contrast, the CEO of Valeant, J. Michael Pearson (a former McKinsey consultant),is said to view the matter more from the vantage of "financial engineering". In particular, Mr Pearson emphasized that he would focus on acheiving cost-cutting efficiencies, especially in the marketing of Provogil and other drugs when they come off patent protection. Moreover, he would spend less on R&D in favour of entering into partnerships to develop commpounds. In the spirit of financial engineering, Mr. Pearson also noted in a letter that since Cephalon has itself recently made two offers for acquiring companies, this will "... reduce your cash on hand by over $400 million dollars, which makes Cephalon a less attractive acquisition from our standpoint."

These two views reflect the quite different histories of the two companies. Cephalon was established in 1987 and it focuses on drugs in the area of central nervous system disorders, pain and cancer treatment. Its founder, Frank Baldino Jr., passed away in December 2010 after being in charge of the company for more than 20 years. While the company faces an imminent patent cliff next year, it remains fixed, it seems, on a strategy based of continued R&D to develop new products.

Valeant deals in both branded and generic drugs and it has a particularly interesting past. A former CEO, Milan Panic (and also a former prime minister of Yugoslavia) disposed of $1.24 million in stock, only thereafter disclosing that a major drug lacked regulatory approval. The present company itself is the product of the merger of several pharmaecutical companies. If Mr Pearson's announced intention to deemphasize R&D on the part of Cephalon is an indication of the company's general view on the issue, R&D would seem to be taking a back seat to more downstream development and commercialization.

All of this raises the larger question: whence will come the drivers for the next generation of patented drugs? The belief is sometimes expressed that nimble start-ups (like Cephalon) are a prime source for future dynamic R&D. The trend of Big Pharma to seek to acquire companies, rather than to invest these amounts in internal R&D, supports this view, at least in part. On the other hand, Valeant is hardly Big Pharma, and its announced strategy lying behind the proposed acquisition is hardly a vote of confidence for the ability of a one-time start-up such as Cephalon to continue to be a source of fruitful R&D, at least not on its own.

And so the question remains: whence will come the drivers for the next generation of patented drugs?